The City of London's legal market is arguably the most competitive in the world. Ten years ago, there were only a handful of top law firms populating the City. However, with London's ever-increasing significance as a global crossroads, things have changed quite a bit over the past decade.

The key moment came in the mid-90s, when British law was modified to allow American lawyers to go into partnership with English lawyers. Since then, American firms have been flooding in and show no signs of slowing down. While a few English law firms might harbour ambitions to open offices in New York, their colonial proclivities pale in comparison to the Americans', as the number of American firms doing business in London now tops 100. The top 50 of these, according to London law magazine Legal Business, now employ more than 3,000 lawyers in the capital alone -- 2,200 of them English qualified. It's no secret that the aggressive American firms have a comparative advantage: a lot of money to throw around.

The Americans can afford to pay more because they are, by and large, more profitable businesses. A part of the reason for American firms' relative success is that they haven't made the extensive overseas investment that many top English law firms have. A larger reason lies in the U.S. litigation culture and its mind-boggling revenues. Of course UK firms do litigation, but it's a smaller part of their business, constituting 10-20 percent within the Magic Circle. This would be highly unusual for a major American firm, as it is typical for half of a U.S. firm's lawyers to work solely on the contentious side of the business. Of added significance is that litigation is not only profitable, but counter-cyclical;, when capital markets and M&A were quiet at the start of this century, American law firms saw no dip in revenue while UK firms suffered. Even when businesses aren't merging, absorbing and raiding one another, companies love to sue -- which means a steady flow of cash to the firms representing them.

Last year was a banner one for U.S. firms doing business in London. According to The Lawyer, virtually every American law firm saw solid to stellar performance in '05. Debevoise & Plimpton, for example, posted an unprecedented 67.5 percent increase in revenue coming out of the London office (accounting for 10 percent of Debevoise's total revenue in 2005). LeBoeuf Lamb Greene & MacRae reported similarly impressive earnings, marking 2005 with a 43 percent rise in UK revenue. Meanwhile, Shearman & Sterling's UK partners took home, on average, ??950,000 -- not a great leap over 2004's figures, as The Lawyer reports, but still 20 percent higher than the global average for profits per equity partner (PEP). Dechert partners also had some cause for celebration, as 2005 saw the firm's UK revenue climb by 15 percent and UK PEP leap nearly 30 percent to ??846,500. White-shoe Wall Street firm Simpson Thacher boasted a 30 percent rise in UK revenue. Impressive numbers like that (with equally impressive profits per equity partner) will surely demand the attention of both English lawyers and their employers -- English firms.

When it comes to the war for talent in the London market, U.S. firms take a different approach to partner compensation, which has attracted some of the England's top advocates. As a rule, Americans pay partners according to how much work they generate (a.k.a. the 'Eat what you kill' rule). The largest UK firms, on the other hand, pay partners according to seniority. This means that the highest-billing at English firms (rarely the most senior, rarer yet the highest-paid) would be better off parlaying their professional zealotry into higher earnings at a U.S. firm.

There are other factors luring English attorneys to American firms, of course. As The Lawyer reported in March 2006, the recent defection of two high-level Linklaters private equity partners to Chicago-based Kirkland & Ellis seemed linked to tension between Linklaters' private equity team and its banking group. Kirkland, operating through a headhunter (who, according to The Lawyer, blabbed about the move months in advance), capitalized on Linklaters' internal strife, taking Graham White and Raymond McKeeve -- along with a portable book of clients including CVC and TDR Capital. The move demonstrates that American firms -- which, being comparatively new to the market, are freer to try new things -- may be more willing to accommodate disgruntled attorneys' professional whims than traditional UK firms.

All of this means that for a talented lawyer entering London's legal market, U.S. firms offer a viable -- and rather lucrative -- alternative as a place to begin a career. However, you would be gravely mistaken to think you can make a killing working at an American firm without putting in American hours. As a result of the whizbang billable ethos, all of the law firms in London (American and English alike) now expect their associates to earn their keep, and then some.

A little M&A

The second half of 2005 and early 2006 have seen the first signs of serious mergers and acquisition (M&A) activity reappearing in Europe since the downturn that began in 2001. When M&A and capital markets went quiet following the dot-com crash and the 11 September attacks, English law firms, like so many businesses around the world, found things difficult. After a decade of unprecedented expansion both in their London offices and their international networks, firms suddenly found that they had a lot of lawyers with very little to do. That's an expensive overhead, and through a combination of redundancies and aggressive performance reviews, the numbers of fee-earners were driven down to more manageable levels.

The six so-called Magic Circle law firms in London are, in order of turnover, Clifford Chance, Linklaters, Freshfields Bruckhaus Deringer, Allen & Overy, Slaughter and May, and Herbert Smith. These are the firms widely recognised as dominating the corporate work and advising on the highest value litigation and capital markets transactions. All six have had to focus on raising their profitability levels in the wake of the economic downturn, not least to keep their partners happy in the face of tempting offers from the Yanks. The result has been a paradigm shift: like their U.S. counterparts, there is an increasing focus on the dreaded billable hour. Lawyers are expected not only to log the hours, but to be on call for clients day and night. Annual targets of 2,000 billable hours are not unusual as the days of long lunches and carrying less productive colleagues have become a thing of the past.

Return of the good old days

Law firms in London, wherever headquartered, are cautiously optimistic that the market is only going to improve. M&A seems to be coming back, with big deals like Spanish telecoms group Telef??nica bidding a grand ??17.7bn for English mobile company O2. The merger, if and when executed, would break records as the largest takeover of a UK company since 2000. There are also rumours of a multi-billion quid bid from another Spanish company for UK airports operator BAA. Meanwhile, UK gas group BOC has been the subject of a $14.9bn bid from Germany's Linde. More recently, ports and ferries group P&O had been at the heart of a bid battle between rivals in Dubai and Singapore. Last year, however, DP World (the same Dubai Ports involved in the recent American uproar over ports control), agreed to a ??3.92bn takeover of P&O.

The other big corporate work for law firms is in capital markets, which has been a dismal state of affairs since 2000. With the world's two largest capital markets in New York and London, it's readily apparent why law firms are so keen to establish themselves in both markets. But a confluence of ill-fated events -- the dot-com bust, the 11 September attacks, and widespread corporate chicanery ?? la Enron caused many investors' cash and confidence levels to drop. Since Enron's collapse, the American Securities and Exchange Commission introduced tough compliance and reporting rules for public companies in an attempt to avoid similar blow-ups from happening again. The measures have been a mixed blessing: increased corporate confidence but more red tape. The so-called Sarbanes-Oxley Act in particular makes it a lot more expensive to sell shares in the U.S., and has thus benefited London by ushering businesses to a more forgiving market. As testament to that fact, the number of flotations in London has just returned to something approaching 2000 levels, with 421 IPOs (initial public offerings) in 2005, compared to 486 in 2000. There were only 97 in the year 2002, but with many Russian, Israeli and Eastern European companies now choosing to list in London rather than New York, the UK exchange is again as busy as ever.

Also active on the corporate side is private equity work, with a huge number of private equity houses now investing in ever-larger European businesses. Private equity firms take money from institutional investors and then buy established companies with a view to improving their performance. They then either sell them or take them public in hopes of delivering huge returns to the institutional investors. Since it began as a niche practice during the '80s, this business has developed enormously, with a number of large American private equity firms opening European operations and buying businesses here. Late 2005 saw the record-breaking $12bn bid for Danish telecoms group TDC, the largest acquisition by these buy-out groups ever seen on this side of the Atlantic.

Practice makes perfect

For all the sizeable English law firms, the return of corporate work is the most important development for their practices since 2000, as it is the mainstay of their revenue and profit generation. Other departments, like real estate, banking and litigation, are less cyclical and often less remunerative than the big M&A and capital markets work. That said, business is now booming across the board for most firms. The property and projects teams are kept busy through a combination of building work for the Olympics (coming to London in 2012 -- sorry Paris), and the arrival of a new UK law that introduces property investment vehicles to England for the first time. These so-called Real Estate Investment Trusts, or REITS, are immensely popular in the U.S. and continental Europe.

The litigation market is also busy, with the UK emerging as a major centre for international arbitrations, and the increasing prospect of U.S.-style class actions coming to Europe. Cases like the Railtrack litigation, where a group of shareholders came together to sue the UK government over its handling of the company's demise, are seen as the forerunners of group actions this side of the pond.

But while the Magic Circle firms may be returning to form, they now view their competition in Europe as the U.S. firms that have built significant presences here -- firms like Latham & Watkins, White & Case, Shearman & Sterling and Skadden. Historically, a second tier of major UK firms would have challenged the Magic Circle for big deals, but those practices -- Norton Rose, Lovells, Simmons & Simmons, Denton Wilde Sapte and Ashurst -- are finding it ever harder to compete.

It is that second tier of UK law firms that has been hardest hit by the arrival of American law firms. They have lost some of their best-performing partners and, in many cases, have been unable to compete like their Magic Circle colleagues. This group of firms is also squeezed from below by the national UK law firms, which can compete by offering more competitive billing rates to clients, and are frequently more entrepreneurial and aggressive in addition to being tightly managed. The likes of DLA -- which merged in 2005 to form DLA Piper Rudnick Gray Cary, the third largest law firm in the world -- Eversheds, Addleshaw Goddard and Pinsent Masons, now give the London firms a run for their money.

National goes international

DLA is an interesting case in point. The firm began in Sheffield, and as recently as five years ago was regarded as a regional law firm with ambitions to make its mark on London. That is precisely what DLA achieved -- the firm's business model is based on hiring a few high quality partners, paying them a lot of money, and getting the work done by more junior people often operating out of less costly regional business centres.

Such leveraging, as it is called, may concentrate the power in the hands of the few, but it satisfies the clients, who get a cheaper and more commercial service. DLA's combination with two U.S. law firms in 2005 takes the model one step further. While it may not compete with firms like Clifford Chance and Skadden Arps for M&A work, it will pick up global mandates from clients looking to use one firm worldwide for all sectors.

But size isn't everything, and the firms at the polar opposite from DLA have done well by staying small and focusing on filling a niche. This group in London includes Macfarlanes, SJ Berwin and Travers Smith, three corporate firms that continue to attract some of the biggest domestic work around, and Berwin Leighton Paisner, which is arguably the top law firm in the UK for real estate work and has now added a strong corporate and finance business on the back of that brand.

These firms do not have the costly international networks of their larger rivals, but instead work in collaboration with independent firms in other jurisdictions when they must. This strategy, dubbed a 'best friends' model and demonstrated on a larger scale by the strategy of Slaughter and May (the only Magic Circle law firm without an overseas network), is attractive to certain clients. Macfarlanes, for example, last year advised its longstanding French client Pernod Ricard on a ??7.6bn takeover of UK rival Allied Domecq.

Merger market

For UK firms looking to expand across the Atlantic, a merger maybe the smartest move. Freshfields Bruckhaus Deringer announced at the start of 2006 that it is hoping to merge with an American law firm in the next five years. New York is the only significant financial market where the firm has yet to establish a sizeable presence, and the firm says that the only way to do so is to combine with a U.S. law firm. Freshfields, along with Clifford Chance, Linklaters and Allen & Overy, is one of a so-called Global Quartet of UK law firms. Clifford Chance merged in 2000 with New York firm Rogers & Wells -- a merger that was beset by difficulties and is only now settling down after a series of departures. Allen & Overy and Linklaters have both decided to build their New York offices by hiring lawyers from U.S. firms, despite the fact that they can rarely offer them more money than they are earning elsewhere -- a hard sell at best.

To date, the transatlantic mergers of law firms have usually involved at least one second-tier law firm, with the deal by DLA being the first true merger of equals, albeit outside the Magic Circle and Wall Street domain. Chicago firm Mayer Brown & Platt took over City corporate boutique Rowe & Maw in 2002, and in 2003 Cleveland's Jones Day took over another small City firm, Gouldens.

While there is still no shortage of American law firms looking to break into the European market by acquiring an existing, established practice, most firms prefer to take over smaller ones and impose their own corporate culture. The top U.S. law firms are both much more profitable, and much smaller, than the top English firms. Skadden Arps is the largest, with 1,600 lawyers, compared to 3,300 lawyers at the UK's largest firm Clifford Chance. The average Skadden partner earns $1.7m, while at Clifford Chance the average is $1.2m.

If Freshfields succeeds in convincing a top-tier New York firm that it wants to be taken over by a larger, less profitable, European suitor, it will undoubtedly lead to a raft of similar deals, as clients reconsider their options.

Consolidation, transformation

For now, the most likely law firm mergers are likely to be domestic or pan-European. These are easier to achieve, and there are many firms outside the Magic Circle who feel they simply need more resources to compete with their larger rivals.

If that isn't enough to make the London legal market a darn interesting place to be for the next few years, consider that the government is planning some pretty serious reforms of the rules governing law firms. Parliament asked Sir David Clementi, a former chairman of the Prudential, to review the market for legal services last year, and he made some serious recommendations which look set to totally transform the way law is practiced in the UK.

Chief amongst Clementi's suggestions: a change to the current law which allows only lawyers to be partners and owners of law firms. That means that big businesses, including retailers like Tesco, might buy a law firm so that they could offer their customers legal services, in addition to the host of insurance and financial services products they currently sell. It also means accounting firms might team up with legal firms to offer a one-stop shop advisory service to clients., or law firms could make their finance directors partners. The permutations are limitless. Even more fundamental, is the prospect that law firms might one day float on the Stock Exchange, and thus raise cash from external shareholders to make investments. The government is still deciding precisely what form the new rules will take, but there's no doubt that big changes are on the way.

In demand

The London legal market is buzzing again, and young lawyers are once more in high demand. In 2000, a global salary war originated in Silicon Valley, when law firms hiked wages to prevent associates from fleeing to dot-coms offering big perks and even bigger bonuses. The fever spread to New York, where attorneys were leaving for the investment banks, and then to London.

When the market went quiet, associates were worried about losing their jobs, rather than inadequate salaries. Now that firms are busy, they are once again short of staff. The battle to hire the best lawyers, and the brightest graduates entering the profession, has arguably never been tougher, as this time around there are not just UK law firms but sizeable UK offices of American law firms looking to hire the best people.

Salaries are rising again, but wage is not the only factor driving job-seekers' decisions. Firms now look to attract people by showing that they take things like diversity initiatives, corporate social responsibility, and flexible working policies, seriously -- things that were neglected at the expense of profit drives over the last few years.

The pressure to keep profits up means the chances of making partnership in any law firm are now scarcer than ever. Law firms operate an up-or-out policy -- you join a track to the partnership, and each year you are appraised to see whether you are still in line for the prize. Fewer and fewer make it now, but for those who do, the lucre is filthy.

The American law firms in London offer a whole new set of options for young lawyers. They pay more, no doubt, and whilst they still have a reputation for longer hours, it's now fair to say that all serious law firms in London bow down to the almighty billable hour. Smaller offices -- most U.S. firms still have less than 100 lawyers in the UK -- mean more responsibility earlier on, but they can also mean a shortage of resources and partner time for tutoring. The training schemes may be less developed, but the work is just as good. English law firms are another matter entirely, and have a huge battle on their hands: to attract the best lawyers, to retain their market share in their home market, and to win on the incredibly competitive global legal stage.